10/19/2001 @ 2:54PM

Investment Newsletters 101

Investment newsletters are the irregular troops, the guerrillas, of the investment world. There are always an indeterminate number hiding “out there,” behind bushes, rocks and arcane investment theories. They actually come in all shapes and sizes, but typically the only ones that Wall Street hears about are run by charismatic showmen like
Joe
Granville
Joe Granville
of The Granville Letter. On stage at an investment seminar, Granville once dropped his tuxedo pants and pointed to stock symbols printed on his boxer shorts, culminating with a delighted cry of “And here’s Hughes Tool!” Wall Street prefers subtler showmanship–oak panels and private planes. The Street’s attitude to investment letters has been dogmatic and dismissive.

And the financial media, interestingly, has tended to follow Wall Street’s lead. For years, the Wall Street Journal would not accept any advertisements from investment newsletters, presumably because it thought they were frauds. Similarly,
Burton
Malkiel
Burton Malkiel
has roundly dismissed investment newsletters in all seven editions of his book, A Random Walk Down Wall Street.

This dismissiveness is a big mistake. To be sure, there are investment newsletters and tout sheets whose sole purpose is to promote certain stocks like PR firms. However the same criticism can be made of Wall Street firms like
Merrill Lynch
and
Morgan Stanley
. Some investment letters have research departments as big and earnestly number-crunching as many small brokerage boutiques, such as
Charles
Allmon
Charles Allmon
‘s Growth Stock Outlook or the Dow Theory Forecasts. For another thing, it is simply an unpalatable truth in life that, just as paranoids can have enemies, so also can snake-oil salesmen have snakes once in a while. Or oil.

What made dismissing the investment newsletter business untenable was the advent of
Mark
Hulbert
Mark Hulbert
and his Hulbert Financial Digest (HFD) monitoring service in 1980. Hulbert’s service provided the first-ever objective monitoring of investment newsletter performance–previously a cloud of confusion, conjecture and con tricks.

But it wasn’t just Wall Streeters and financial journalists who dismissed investment newsletters. The established orthodoxy among academics who study the stock market was “the “efficient market hypothesis” or EMH–the view that the market reflects new information so fast that neither investment newsletters nor Wall Streeters are able to outguess it in the long run. This implies that the most logical course is to fire your investment adviser, buy a diversified portfolio and hold it through thick and thin.

Mark Hulbert’s work has inclined him to different conclusions. These can be expressed in two simple laws:

Hulbert’s Second Law:It may be hard. But it can be done. (Corollary: We know who does it.)

This is in line with more recent work in academe, which focuses on the so-called “anomalies” in the efficient market–peculiar areas where the market does not seem to discount information immediately, and can be exploited to achieve superior returns.

In fact, one of the first of these anomalies to be documented was the superior performance of an investment newsletter, Value Line Investment Survey, and its rating system’s top-ranked Group One stocks. It was written up as early as 1971 by a leading EMH theorist, the late
Fischer
Black
Fischer Black
, then of Massachusetts Institute of Technology. “I continue to be amazed,” he said when I asked him about it in 1985, by which time he had joined
Goldman Sachs
.

Today, Value Line is one of the handful of newsletters that have beaten the market (including reinvested dividends) over the entire 21 years that Hulbert has been active. (The others, as of 9/30/01:
Al
Frank
Al Frank
‘s The Prudent Speculatorand
Dan
Sullivan
Dan Sullivan
‘s The Chartist and
Burton
Berry
Burton Berry
‘s No-Load Fund-X.)

Compared to the investment newsletters, Wall Street is at a disadvantage in finding these anomalies. There is the conflict of interest: The stockbroker is concerned about commissions, the client about capital gains. Investment letters are prepared to give sell signals; the investment banks shrink from them because it upsets their underwriting clients. And there is the inevitable bureaucracy of large organizations: it makes innovation very difficult. By contrast, investment newsletters can (and do) try anything they feel like immediately. They present every conceivable investment technique and style.

This is why we say that investment newsletters are the guerrilla troops of the financial world–Wall Street irregulars. Mark Hulbert tracks their footsteps across the investment minefield. By following them–and halting if they terminate in a smoking crater–you can see what techniques work as well as which would be right for you (two very different things). No more important work is being done anywhere in the investment industry today.

And if it seems surprising that this discovery was made by an ex-philosophy student with his personal computer, remember that two farm boys from Ohio invented the airplane.

Frequently Asked Questions Regarding Investment Newsletters

Question: Can you lose money following an investment newsletter?

Of course you can. And we also know people who lost money with Wall Street advice. Let us be absolutely clear: It’s imperative that you be careful when you choose an investment newsletter. The rule is, emphatically, caveat emptor–let the buyer beware. That’s why Forbes offers access to Hulbert’s data, which includes not just his performance data but customized studies of individual newsletters. We urge you to check it. But with care and the usual amount of luck, investment newsletters can be profitable.

Question: Well, I like this newsletter that doesn’t do well on Hulbert’s ratings. It’s kind of interesting…

That’s perfectly OK. There are many legitimate reasons to buy an investment letter. Mark Hulbert’s ranking system, which constructs model portfolios based on the newsletters’ advice, is a very harsh test. Some people look to a newsletter for odd isolated insights. Others might just like the editor’s writing style–the investment business is partly entertainment, after all. In these cases, the Hulbert rating may not be relevant. But we urge you to always seek an independent analysis of the newsletter’s performance before you invest.

Question: What’s the point of any investment advice? The bull market’s over.

Investors do get turned off when the market stalls. Ironically, however, this is exactly the point at which good advice is most valuable. It’s very easy to beat the market when it’s going down–just be in cash. And if you had taken Maverick Advisor‘s advice this past July, you would have been in cash. (Maverick Advisor is the new name for a well-known, long-lived service: Telephone Switch Newsletter, founded in the 1970s by
Richard
Fabian
Richard Fabian
.) It’s possible to build your portfolio when the market is just going sideways or even falling–but you have to know which stocks to pick. Consider these mouth-watering returns since the January 2000 high. (Through 9/30/01): Medical Technology Stock Letter‘s Model Portfolio (+62.4%); Investor Intelligence‘s Income & Appreciation Portfolio (+61.6%) or Blue Chip Investor‘s Model Portfolio (+48.2%).

And in bad markets, preserving capital becomes the priority. That’s a problem for conventional stockbrokers, because they only make money if you trade. Investment newsletters have no trouble recommending cash, no-load mutual funds or even gold.

By contrast, if the market is just going up, everybody looks great. Good advice can help you to be only so much greater.

Question: Yeah, but I don’t want to spend all my time watching the market.

You don’t have to–unless you want to. The beauty of the variegated newsletter universe is that there is a newsletter to fit every personal style and preference. If you like action, try Wall Street Winners, which on average rates a stock a “buy” for less than three weeks. If you prefer buy-and-hold, try Al Frank’s Prudent Speculator. Stocks in Al’s model portfolio have been held an average of five years. But not everyone has the nerves for the former or the patience for the latter.

Question: I don’t like picking stocks. I prefer to diversify–buy a mutual fund.

Investment letters always appear to cover every new investment technique.
David
Fried
David Fried
‘s The Buy-Back Letter uses a technique that derived from an academic journal article published only in 1995. His buyback stocks are in first place, according to Hulbert, on a risk-adjusted basis over the last four-plus years.

Question: This obsession with equities is a mistake. It’s more important to pick the right sector–stocks, bonds, cash, real estate, precious metals.